I have pretty large balances on 2 credit cards plus a car loan. Through a private lender (family member) I can pay off all of the debt - roughly $50k - and pay back the family member interest-free at my own pace. Obviously the interest savings alone would be beneficial to me.
However, I recall that a couple of times in the past that I’ve paid off large chunks of credit card debt in one fell swoop, the card company actually cut my debt limit. I called them and they said that they don’t like to see “unusual” payback activity.
So while this seems like a slam dunk opportunity for me, I wonder if there are any potential negatives.
Your credit score could go down if your credit limits are dropped. Not a negative though if you don’t plan to borrow for a big-ticket item any time soon.
Assuming the family member will loan you the money no matter what you do with it, by paying off debt early you are losing the opportunity to invest it and make more than the interest rate on the debt. Now, given that we are talking about credit card debt, that seems unlikely. The broad stock market has returned 10% in every rolling 20-year period since the great depression, but I would imagine your rate on the cards is very near that if not over it. Of course there would also be a different risk/reward profile to investing v. paying off the debt, which is something that only you know whether you would be comfortable with.
If I can ride on the coattails of this thread - how about paying off a mortgage early? We’ve managed to wipe out all debts but the mortgage (we use our credit card, but it mostly gets paid off each month.)
We’ve got enough in my TSP (a 401k equivalent for federal employees) to pay off the balance with some left over, altho that would throw us into a higher tax bracket when we yank the money out. My husband like the idea of being totally debt-free, but we do have enough budgeted to cover the mortgage payment and our other expenses comfortably. I just came out of retirement, and I’ve considered dumping most of my pay against the mortgage. What to do, what to do??
As to the OP - could you pay off your credit card debt in maybe 3 chunks rather than wiping it all out at once? Would that make a difference? We’re with a credit union, and when we zeroed our VISA balance, it didn’t affect our credit limit at all. And, as I mentioned, we still use it, but we don’t carry the big balance any longer. My daughter paid off a large VISA balance, then asked her credit union to lower her limit - she recognized that she wasn’t disciplined enough to handle a high credit limit.
I say pay them all off as soon as you can, and screw the banks crying that they’re losing potential decades of interest. Thumb your nose at them, say ‘neener neener’, use your free and clear house as collateral if you need money in the future, and tell the credit card companies that you don’t NEED their credit…or at least, not as much. Yeah, having a card around is good, but the game requires you play it, and I think it’d be better to just keep your ball and let them go play with themselves if they don’t like your rules. If they don’t want to give you credit, fine. Someone will, should you need it.
Sorry…/rant off.
Generally speaking, the largest and most significant downside to paying off debt early is that you burn up all of your cash reserves.
As an example, say you have $10k on a credit card, and have $2k per month available. You could put all of that $2k towards the credit card and pay it off in 5-6 months (interest).
But that would leave you without any cash available. So instead you could put $1k towards the card and put $1k in savings.
The benefit here is that if anything else happens over the next 5-10 months you won’t need to take on more debt.
Same sort of thing applies to a mortgage, but slightly different because your mortgage has fixed payments intended to pay off the loan (unlike the minimum on a credit card bill). Paying more into the mortgage doesn’t change your monthly payment, and burns up all of your cash reserves. People that do this are very likely to need higher interest loans in the future when something breaks. Now they have two payments to make instead of one.
If you can pay off the loans do it, there is no reason to carry debt. But part of that is to consider long term by making sure you aren’t going to turn around and need a lot more debt a month later (when the car breaks down).
Without knowing the specific details of your finances, do not take money out of your TSP to pay off your mortgage. Since you just came out of retirement, take your earnings (as much as you can spare) and pay down the mortgage with it. If you are meeting you current expenses comfortably, consider going commando for a set time period (three months, six months, whatever) and cut expenses to the bone. Take the money you are saving and dump it into the mortgage principal.
Or perhaps take that extra cash and build and emergency cash account. There used to be a rule of thumb of three months of net income. That amount has slowly creeped up to be six, maybe nine months of net income. Personally, I’m working to create a 12-month emergency fund based on gross income. I, too, want to be debt-free. I recently raised my TSP investment from 11 percent to 15 percent. I’m also making additional principal payments to my mortgage.
This is my thought as well. When my MIL passed away she left us enough to pay off all our debt, except for the house. We paid everything off and bought a late model used car for cash. I think our credit score took a hit, but we don’t really care. We didn’t even keep our credit cards. We don’t have all those other bills to think about every month. It’s been two years and we’ve yet to see any negative consequences.
Any debt that can be paid off early is a good thing unless penalties are involved by doing so. I paid off my Volvo and my first scooter early. Neither loan was for a substancial amount, and the interest was very reasonable, but boy did it feel good to pay it off much earlier than it needed to be. My friend lent me some money for my divorce fees, she tried to let me off the hook when it was all said and done. I paid her back in full anyways. Pay your loans off early…go for it.
When I suddenly paid off $7K of credit card debt in one fell swoop in '04, my credit score fell something like 30-40 points into the 620s (IIRC–I was monitoring my credit scores using MyFico). Anyhow, that hit recovered within a couple of months as they saw normal debt and payment activity, and now I’m back up over 800. Even so, by late '04/early '05 I was at 700, so the hit was temporary. (However, I didn’t not get any limits reduced or anything like that.)
With $50K in loans, I wouldn’t even think twice. Pay off the debts; your score will suffer for a few months, but if you show regular activity on your card and payments (I just paid off at the end of every month–never let a balance ride since that $7K was paid off), it should recover.
For 2, credit card debt is almost always worse than any investment, so that can be dumped. Lots of mortgage rates today, considering tax benefits, are lower than alternate investments.
We have no credit card debt, no car debt, and a reasonably small mortgage now at a pretty low rate. We could pay it off now if we really wanted to, but that would be financially foolish - and kind of timing the market.
I struggle to see the benefit here, given that credit cards charge about 20-25% APR, whereas savings will return maybe 2-3% maximum, unless you have a very large sum to invest.
Surely it’s better to pay off the debt, and then if “something happens” before you build up savings then you can use the card, and still pay that exorbitant interest for less time. The only risk, I suppose, being that the credit card limit gets slashed as soon as you pay it off.
My wife and I are in a similar position to the OP, with large credit card debts that are costing a fortune in interest. A family member has offered to lend us the money to clear them - not interest free, which is fair enough, as they could be earning interest on that money elsewhere. But paying 5% a year to a family member (with a 9-month delay to get our shit together before making the first payment), is a lot better than paying 25% a year to a bank, so we’ll be taking him up on it.
BTW In my experience, when you clear a credit card they often come up with 0% balance transfer offers which can be useful if you have other outstanding debt. However I am planning to close all but one of my credit card accounts, and just keep that one in regular use to improve my credit score. (My credit score is actually pretty good - lots of card accounts, no missed payments, but high debt overall. Just the sort of customer the banks love )
Sorry for the confusion, but you pretty much answered your own question.
The first thing to remember is that not all debt is revolving. A credit card with a $5k limit can be paid down, and then used again. But mortgages, car loans, and student loans can’t. Money paid into them is gone.
The next thing to remember is that usually people with debt started when their credit score was high and now have scores that are low. As a result, the opportunity for credit is worse.
The absolute worse scenario would be for someone to pay off a car loan, have the car brake down, then end up at a cash advance place paying 700% interest because they have no cash.
When it comes to debt repayment, everything needs to be lined up and a schedule set for repayment. That schedule needs to allow for cash savings in the event something goes wrong so that there isn’t a need for more debt. Let me see if I can come up with a reasonable example:
$5k in credit card debt, 12% interest
$5k in car loan at 18% interest.
Person brings in $2k per month after taxes.
The repayment plan needs to take into account all of the living expenses, and then account for enough savings. What’s left should go to the higher interest loan first. Remembering that money paid down on the credit card could be used in an emergency, where as paying the car loan can’t.
Lumping those together in one $10k loan is a good idea, so long as the repayment structure doesn’t wipe out the ability to for cash savings. Then after the debt is paid off, the cash savings start to grow really fast, and debt is avoided. After that the cash starts earning interest.
That’s what I did, and I don’t regret it. Please take caution though, because I’ve always played by different rules than most people. Not married, no family, so I can pretty much do as I please.
Hijack: What the fuck is the rationale for paying off debt early resulting in a WORSE credit score?
That sort of thing pisses me off. I’ve never paid a bill late in my entire life, yet my credit isn’t great. And why are credit scores on double secret probation? The bank even LOOKING at the score somehow affected it when I got my mortgage. They had to pass a law so you could even get a credit report yourself. Fortunately, this only pisses me off in theory since I’ve paid off all my debt and own a home outright. But the whole credit score thing seems like one of the biggest piles of steaming crap humanity has ever come up with.
I’ve started to figure (could be wrong) that it’s because your credit score isn’t actually an assessment of how reliable you are in repaying debts, the way I initially assumed. It’s an assessment of how much money a creditor is likely to be able to make from you. So if you pay off your credit card bill in full every month, or pay off a loan early, you’re not paying the company interest - so no credit score for you. If you run up the CC to its max and take years to pay it off at 20%, your credit score goes up to reflect the fact that you’re a profitable target for a loan.
Basically, it’s not about how good a risk you are, it’s about how good a source of interest payments you are.
I pay off my credit cards completely every month, and have done so for years and years. the CC companies make a percentage on each transaction, but they collect no interest or late fees from me. I bought a motorcycle a few years ago with a five-year loan, but I paid it off after about a year.
Yeah, like I said, I pay off every month (at least since paying off the cards 8 years ago) and my score is 800. Same with my wife and her score.
The rationale I read had something to do with large sudden payments suggest you’ve either secured another loan the credit companies don’t know about, so make you more of at risk, or at least temporarily. Or something like that.
That depends a lot on the specific conditions, you need to run the calculations. For example: the way mine is set, there’s no fee for reducing the principal in advance, but there is one for cancellation; right now, if I closed it all and assuming interest rates stayed at their current level or lower, I’d be losing some money.
I’m trying to find a source for that, but I can’t find it now for some reason. I read about it when I paid off my credit card debt in 2004. Most of the stuff I find now say that your score can go down if you close an account, or because your credit utilization goes down, or things of that nature, but none of that applied to me. I didn’t close down the card, my utilization DID go down, but from being at 100% of my max credit down to 0%, so surely the 100% utilization pinged my score more than going down to 0%. The only difference I had was I had 4 credit cards, 3 with $0 balances and 1 with a $5-$7K balance (I think I was down to $5K when I paid it off.)
So, when you have a customer who has for years carried a balance and made $200-$300 payments every month all of a sudden comes up with $5K to drop and clear the balance, after having 3 months with missed payments a year previous, you kind of gotta wonder what happened. I could see the model being programmed to exercise caution for the next few months until you establish creditworthiness. I don’t think that’s so crazy an idea.
You said you had two credit card debts and a car debt, but it looks like most of the responses are addressing your credit card debt.
I owe some money on a car loan that I could pay off right now. But I have a 1.9% interest rate, and I presume that if I ever want to get a loan for something else the interest rate would not be as low, so I kind of feel better off not paying it all right now.
This as much of an invitation for other people to give their thoughts/approval/disapproval as it is an opportunity for me to share my reasoning, by the way.
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